Archive for the ‘Financial Planning’ Category

Faced with a turbulent stock market and an economy in flux, we are increasingly worried about our finances. And though investors admit to financial planners’ expertise, few consult one. So says a survey the AICPA commissioned to better understand how we manage our money.

Harris Interactive, an Internet-based market research firm, conducted the survey, “Report on America’s Financial Health,” for the AICPA. Almost all respondents (91%) said they manage their finances themselves, doing their own research, and obtaining advice from family, friends, the Internet, or a broker. The survey revealed that almost three out four respondents (71%) have been thinking more about their finances in the last three years. But only 20% thought they were very prepared for retirement. Others were uncertain about their financial future, 81% were not sure their investments were earning as much as possible and 57% were not certain they knew how to minimize their taxes through proper planning.

The survey also revealed that even individuals who felt confident about their money management skills may have been off the mark. More than half of those who believed they were maximizing savings and earnings felt this way because they had personally researched their mutual funds, understood how much investment risk they should take, had a short-term savings plan or owned real estate. But almost 90% of the respondents lost money in the last six years because of quick decisions they made about financial matters without talking to a planner.

Why didn’t more of the investors consult one? Most sought out professional advice in special situations rather than as a matter of overall strategy. For example, respondents said they would contact a financial planner if they inherited money, wanted to plan for retirement, needed estate planning advice, wanted to rollover 401(k) or IRA funds or were confused by changing tax laws.

Tips for Your Asset Allocation

There is no one-asset allocation formula suitable for all investors. You must evaluate your risk tolerance, time horizon, and rate of return requirements in order to determine how you should allocate your portfolio among the various investment categories. Consider the following:

• The idea behind asset allocation is that different investment categories are affected differently by economic events and market factors. Some asset classes move in opposite directions (negatively correlated) while others move in the same direction (positively correlated). By investing in different types of assets, it is hoped that when one asset declines in value, other assets will increase in value.
• Investments with higher return potential generally have higher risk and more volatility. While most investors want higher returns, they may be uncomfortable assuming higher risk levels. Asset allocation enables you to combine more aggressive investments with less aggressive ones. The combination can help reduce the overall risk in your portfolio.
• Not only should you diversify across broad investment categories, such as equities, bonds, and money market funds, you should also diversify within the category of equities. For instance consider large-capitalization stocks, small-capitalization stocks, value stocks, growth stocks, and international stocks.
• Determining your risk tolerance is one of the most important components of asset allocation. You are determining your emotional ability to stay with an investment when the returns are less than expected. The last two years should serve as a good framework for that assessment.
• The longer your time horizon, the more aggressive you portfolio can be. Those with a time horizon of less than five years should not be invested heavily in equities. Look at bonds and money market funds for your short term needs. As your time horizon increases, you should have a higher percentage of equities in your portfolio.
• Have reasonable return expectations. Basing your portfolio on a rate of return too high may cause you to increase the risk in your portfolio.
• Rebalance your portfolio at least annually, if warranted. With time, your asset allocation percentages will change from your desired percentage as a result of varying rates of return for your different investments.
• Be patient. The results of an investment program are best evaluated over a period of years, not days, weeks, or months.

1. Start now, not later.
2. Set reasonable savings goals, and then live below your means. Being frugal is the cornerstone of wealth management.
3. Know what to expect based on a long history of investor experiences. Look at average rates of return over long periods of time.
4. Manage your risk – it can’t be avoided. There are two types: Volatility – actual returns vary compared to expected returns. Inflation – relates to losses in purchasing power.
5. Diversify.
6. Maintain a long-term perspective – the market rewards the patient investor.
7. Do not attempt to time the market on what you or the experts expect the market to do.
8. Know what your costs are – avoid loads, commissions, and expensive investment advice.
9. Beware of the experts.
10. Defer taxes unless unavoidable. Pay later than sooner.

For those of you who have procrastinated in the past about doing financial planning, Now is a “perfect time” to map out your strategy.

What follows is a brief outline of the areas you need to address:

1. Determine your spending habits.

• Look at your expenditures from last year.
• Break them out between necessities (food, utilities, transportation, mortgage payments, rent, etc.) and non-necessities (vacations, hobbies, entertainment, recreation etc.).
• Make sure you have three to six months of cash available in case of an emergency, such as an unexpected job loss, in order to cover the necessity type of expenditures.
• Also, set aside amounts for planned expenditures such as a vacation or the purchase of a new car.
• Finally, determine if you can cut back on any of your expenses.

2. Determine your net worth.

• Begin by adding up the value of your assets (house, car, boat, investments, 401(k), etc.).
• Next, subtract the amount of your liabilities (mortgage balance, credit card debt, loans, etc.).
• The result is your net worth.

3. Prepare a credit plan.

• As a result of determining your net worth, you know the exact amount and nature of your debt.
• Begin by checking your credit score report (www.myfico.com).
• If you have too much credit card debt, create a realistic pay-down plan.
• Find a credit card company that offers the most favorable terms on balance transfers, and use the new account to consolidate your debt balances, but consider any negative impact on your FICO score first.
• Make sure that you stick with your pay-down plan.

4. Determine your philosophy relative to investing.

• Write down your long term and short-term goals (why you are investing).
• Determine you risk tolerance (what mix of investments will allow you to sleep at night).
• Consider your tax situation and how often you want to rebalance your mix of investments.
• Remember, investments are only a vehicle to help you attain your goals and objectives.

5. Do tax planning throughout the entire year.

• Maintain good records. Keep receipts.
• Analyze your current social security statement for accuracy.
• Consider the tax implications of any major expenditure.
• Review your prior year tax returns to become more familiar with the type of income and deductions you typically incur.
• Educate yourself relative to the tax nuances for your income and deductions.

6. Make sure you have adequate insurance (property, health, life and disability).

• Appropriate insurance coverage is critical to any financial plan. This is not area where you want to skimp.
• Make a list of all coverages.
• Determine your deductibles, over all limits, co-payments, premiums, etc.
• This should be reviewed annually and discussed with your insurance agent.

7. And finally, resolve to save more.

According to the IRS, the average tax refund this year so far is around $2,000, about a 2% increase over last year. I often hear people asking one another “how much was your refund this year” and most people proudly respond by stating the dollar amount of their refund. I cringe when I hear this conversation. They don’t realize that they have provided our federal government with an interest free loan. The IRS will not do this for you! But, more importantly, they overpaid their income taxes by approximately $170 per month, primarily through excessive payroll withholding, or quarterly estimated payments, resulting in significantly less cash flow. These amounts should have been directed into some appropriate type of savings vehicle or paid down credit card debt.

Most people do not discuss the amount of their total tax liability (the amount of tax based on your taxable income before any payroll withholding or quarterly estimated payments) but discuss the amount of their refund or how much they owed. To a great degree, you control the size of your tax bill every April 15. Strategic tax planning throughout the year can decrease your tax liability. Also, if you consistently receive large tax refunds from year to year, decrease your withholding exemptions (ask your employer for Form W-4) or decrease quarterly estimated tax payments.

If you are self-employed, or are operating a side business in your spare time, you have special tax problems and tax opportunities.

Retirement Plans: You may be able to shelter all, or a portion, of your self-employment income even if you are covered by a plan through your employer.

Estimated Tax Payments: If you have self-employment taxable income you may have to make estimated tax payments throughout the year or incur an underpayment penalty. For 2007, one way of accomplishing this, would be to pay in 100% of your 2006 tax liability, or 110% of your 2006 tax liability if you had adjusted gross income in excess of $150,000. The other way is to pay in 90% of the 2007 tax liability.

Health Insurance Premiums: You may be able to deduct 100% of your premiums paid in 2007 as an adjustment to income on your Form 1040. The only limitations are (1) the amount can’t exceed your net earnings from your business, and (2) you can’t have been eligible to participate in a subsidized health plan of your employer or your spouse’s employer.

Home Office: If you use your home to conduct your business, a percentage of the ongoing expenses, including depreciation, may be deductible. The percentage is based on the square footage used for the office in relation to the entire home.

Employ your Children: This technique allows you to shift income to your lower-bracketed children and to get work done in the process. Earned income is not subject to the so-called “kiddie” tax. This only works if the work is legitimately performed and the amount of the compensation is reasonable.

Asset allocation is your target mix of stocks, bonds, and cash. Without periodic monitoring, your allocations may stray considerably from your target allocation.

For you to maintain your asset allocation and risk-control strategies, you should:

• Check your asset class weightings semi-annually, or minimally annually.

• Rebalance whenever any asset class has strayed more than 5% from your target allocation.

• Time your rebalancing to coincide with a memorable date, such as a birthday or an anniversary.

It is best to rebalance tax-deferred accounts (401(k) or IRAs) first, since there are no tax consequences. Also, you should determine the amount of any related transaction costs.